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Caution to insurers – new duty to defend opinion issued by New York’s High Court

A liability insurer found to have “breached its duty to defend…may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him.” This is the latest pronouncement from the New York Court of Appeals in K2 Inv. Group, et al. v. Am. Guar. & Liab. Ins. Co., No 106 (June 11, 2013). A copy of the opinion is available here.

In this case, the insured, a lawyer, was sued by K2 Investment Group and ATAS Management Group (the “plaintiffs”) for failing to record two mortgages. The insured notified his malpractice carrier of the suit, and later of a settlement demand from the plaintiffs. The insurer, however, denied defense and indemnity coverage, arguing, inter alia, that the allegations against the insured were “not based on the rendering or failing to render legal services for others.” The insured subsequently defaulted and the plaintiffs took a default judgment against him in excess of policy limits. The insured then assigned to the plaintiffs all of his rights against the insurer. The plaintiffs followed by suing the insurer for breach of contract.

The insurer moved for summary judgment, relying on two policy exclusions. The plaintiffs cross-moved for summary judgment, arguing that the insurer breached its duty to defend and was thus bound to pay the judgment against the insured up to the limits of the policy.

The trial court ruled in favor of the plaintiffs. This ruling was affirmed by a majority of the Appellate Division, which held that the exclusions relied upon by the insurer were inapplicable to the malpractice claim upon which the default judgment was based. See K2 Inv. Group, et al. v. Am. Guar. & Liab. Ins. Co., 91 A.D.3d 401, 403 (N.Y. App. Div. 1st Dep’t 2012) (also holding that “the allegations of legal malpractice were focused solely on [the insured’s] negligence as plaintiffs’ counsel;” that is, the allegations were in fact based on rendering legal services).

The Court of Appeals then had its turn. The panel first held that “[i]t is quite clear that [the insurer] breached its duty to defend — indeed, it does not seem to contend otherwise now.” The panel next determined that it was not necessary to reach the issue of the applicability of the exclusions invoked by the insurer because, “by breaching its duty to defend [the insured], [the insurer] lost its right to rely on these exclusions in litigation over its indemnity obligation.” In other words:

an insurance company that has disclaimed its duty to defend ‘may litigate only the validity of its disclaimer.’ If the disclaimer is found bad, the insurance company must indemnify its insured for the resulting judgment, even if policy exclusions would otherwise have negated the duty to indemnify.

(The court did note that exceptions to the foregoing rule could exist, including in cases where public policy prevents an insured for obtaining coverage for his intentional wrongdoing).

This is the second decidedly pro-insured decision out of New York’s highest court in less than a week. See J.P. Morgan Securities v. Vigilant Ins., No. 113 (June 11, 2013) (for a summary of this decision, please click here).

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